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The Roving Cavaliers of Credit

The Roving Cavaliers of Credit

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Published by: qmunty on Jun 19, 2011
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The Roving Cavaliers of Credit
By Steve Keen
Published in January 31st, 2009Posted by Steve Keen in Debtwatch
 “
Talk about centralisation!
The creditsystem, which has its focus in the so-called national banks and the big money-lenders and usurers surrounding them,constitutes enormous centralisation, andgives this class of parasites the fabulouspower, not only to periodically despoilindustrial capitalists, but also to interferein actual production in a most dangerousmanner— and this gang knows nothingabout production and has nothing to dowith it.” [1]
 Ten years ago, a quote from Marx would have one deemed a socialist, anddismissed from polite debate. Today, such a quote can (and did, along withCharlie’s photo) appear in a feature in the Sydney Morning Herald—and nota few people would have been nodding their heads at how Marx got it righton bankers.FHe got it wrong on some other issues,[2] but his analysis of money andcredit, and how the credit system can bring an otherwise well-functioningmarket economy to its knees, was spot on. His observations on the financialcrisis of 1857 still ring true today:
 “A high rate of interest can also indicate, as it did in 1857, that the country isundermined by the
roving cavaliers of credit
who can afford to pay a highinterest because they pay it out of other people’s pockets (whereby,however, they help to determine the rate of interest for all), and
meanwhilethey live in grand style on anticipated profits
.Simultaneously, precisely this can incidentally provide a very profitablebusiness for manufacturers and others.
Returns become wholly deceptiveas a result of the loan system
…”[1]
One and a half centuries after Marx falsely predicted the demise of capitalism, the people most likely to bring it about are not working classrevolutionaries, but the “Roving Cavaliers of Credit”, against whom Marxquite justly railed.This month’s Debtwatch is dedicated to analysing how these Cavaliersactually “make” money and debt—something they think they understand,but in reality, they don’t. A sound model of how money and debt are created
 
 
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makes it obvious that we should never have fallen for the insane notion thatthe financial system should be self-regulating. All that did was give theCavaliers a licence to run amok, with the consequences we are nowexperiencing yet again—150 years after Marx described the crisis that ledhim to write Das Kapital.
The conventional model: the “Money Multiplier” 
Every macroeconomics textbook has an explanation of how credit money iscreated by the system of fractional banking that goes something like this:
 
Banks are required to retain a certain percentage of any deposit as a reserve,known as the “reserve requirement”; for simplicity, let’s say this fraction is10%.
 
When customer Sue deposits say 100 newly printed government $10 notesat her bank, it is then obliged to hang on to ten of them—or $100—but it isallowed to lend out the rest.
 
The bank then lends $900 to its customer Fred, who then deposits it in hisbank—which is now required to hang on to 9 of the bills—or $90—and canlend out the rest. It then lends $810 to its customer Kim.
 
Kim then deposits this $810 in her bank. It keeps $81 of the deposit, andlends the remaining $729 to its customer Kevin.
 
And on this iterative process goes.
 
Over time, a total of $10,000 in money is created—consisting of the original$1,000 injection of government money plus $9,000 in credit money—as wellas $9,000 in total debts. The following table illustrates this, on theassumption that the time lag between a bank receiving a new deposit,making a loan, and the recipient of the loan depositing them in other banksis a mere one week.
 
 
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This model of how banks create credit is simple, easy to understand (thisversion omits the fact that the public holds some of the cash in its ownpockets rather than depositing it all in the banks; this detail is easily cateredfor and is part of the standard model taught to economists),… andcompletely inadequate as an explanation of the actual data on money anddebt.
The Data versus the Money Multiplier Model
Two hypotheses about the nature of money can be derived from the moneymultiplier model:
1. The creation of credit money should happen after the creation of government money. In the model, the banking system can’t create credituntil it receives new deposits from the public (that in turn originate fromthe government) and therefore finds itself with excess reserves that it canlend out. Since the lending, depositing and relending process takes time,there should be a substantial time lag between an injection of newgovernment-created money and the growth of credit money.2. The amount of money in the economy should exceed the amount of debt,with the difference representing the government’s initial creation of money.In the example above, the total of all bank deposits tapers towards

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